Labour’s push for growth hit by latest fall in UK output

Chancellor Rachel Reeves came to office in July pledging to make stronger growth the number one mission of the new Labour government. Official figures on Friday underlined how far she is from achieving this ambition. 

After gaining momentum since 2023, output slipped back in September and October. The figures confirm that businesses and households shied away from spending in the lead-up to a Budget that Prime Minister Sir Keir Starmer warned would be painful. 

The latest figures are “a significant disappointment”, according to Allan Monks at JPMorgan. But what are the key drivers behind the UK’s weak economic performance? 

Pre-Budget anxiety 

Reeves and Starmer made it abundantly clear their first Budget would be a tough one, warning of the need to correct a £22bn in-year overspend inherited from Rishi Sunak’s government and to raise funds to fix struggling public services. 

The lengthy period of uncertainty before October’s Budget damped confidence as businesses and households awaited clarity on tax and spending measures. 

“Growth suffered in the run-up to the Budget, perhaps as worries about higher taxation caused households and firms to postpone spending decisions,” said Andrew Wishart, economist at Capital Economics.

The UK’s poor performance in the second half of the year contrasted with early 2024, when the economy rebounded with 0.7 per cent growth in the first quarter, following a technical recession at the end of last year. 

The fourth quarter of the year could also prove weak, as businesses come to terms with the higher tax burden announced at the Budget, added Yael Selfin, chief economist at the consultancy KPMG UK. 

However, some economists play down the argument that the October slowdown was primarily driven by pre-Budget jitters.

Chris Hare, economist at HSBC, said the UK may be subject to a low growth “speed limit” because of weak productivity. Annual UK productivity growth has averaged only 0.5 per cent over the past 15 years, he noted. “If that productivity issue does not get better, the economy will only be able to grow so fast.”

Bank of England caution

The Bank of England has trimmed interest rates twice this year, bringing them to 4.75 per cent, but the burden of high borrowing costs is continuing to take its toll on the economy. 

Recent analysis from the BoE showed that about half of mortgage holders, or 4.4mn households, will have to refinance their home loans on to higher rates once their fixed deals expire in the next three years.

The BoE is expected to leave interest rates unchanged next week, before trimming them again in the new year.  

It has been reluctant to cut more aggressively given persistently high services inflation. Economists polled by Reuters expect official figures next week to show services price growth of 5.1 per cent in November, compared with 5 per cent in October.

Uncertainty over how the Budget increase in employer national insurance contributions will play out is also hampering BoE decision-making.

A survey published on Friday by the BoE showed that consumers now expect inflation of 3 per cent in the year ahead, up from 2.7 per cent when the question was last asked in August. This will add to the bank’s reluctance to rush through further rate cuts.

Some economists argue that signs of a weakening jobs market mean the BoE is not being aggressive enough in lowering rates.

“A combination of lingering inflationary aversion, alongside the specific pattern around the services inflation data, add to the risk policy remains cautious for longer than it should,” said Ben Nabarro, UK economist at Citigroup, in a note this week. 

Poor consumer confidence

While inflation has subsided since highs exceeding 11 per cent in 2022 and real incomes have been growing for more than a year, concerns about the cost of living are still restraining growth. 

Household savings relative to disposable income have increased this year in the UK and the Eurozone, underscoring a picture of cautious consumers. 

“There’s a risk that household savings rates will continue to rise, which could act as a significant drag on growth,” HSBC’s Hare said. 

Output in consumer-facing industries, such as bars and restaurants, was still 5.3 per cent below its pre-pandemic levels in October, reflecting lower spending as household finances were hit by elevated prices and borrowing costs.

European malaise 

The poor health of the wider European economy is also holding the UK back, given the EU is the country’s biggest export market. 

The Eurozone grew by just 0.4 per cent in the third quarter, up from 0.2 per cent in the previous three months. 

European economies are lagging behind the US, where the economy is 11.4 per cent above its pre-pandemic level, compared with 3 per cent in the UK and 4.6 per cent in the Eurozone. 

The risk of worsening trade tensions in the new year, when Donald Trump takes power in the US, could act as an added drag on European economies. 

“A weakening export climate amid rising global policy uncertainties and declining business confidence, exacerbated by the impact of recently announced Budget measures, raises concerns about sustaining the growth momentum,” said Hailey Low, economist at the National Institute of Economic and Social Research.

Murky prospects 

October’s weak GDP figures raise questions about growth forecasts for next year. In October, the Office for Budget Responsibility forecast growth of 2 per cent in 2025, up from 1.1 per cent this year. 

Analysts are now revising down their expectations. Economists polled by Consensus Economics on December 9 expected growth of 0.9 per cent this year and 1.25 per cent in 2025. Following Friday’s data, Capital Economics downgraded its 2025 growth forecast to 1.4 per cent from 1.6 per cent.  

Even if that gloomier prognosis bears out, it still means next year will be modestly stronger than 2024, however. That is in part because the government’s Budget boosted borrowing and spending, which should support economic activity.

“The outlook for the UK economy next year, relative to the G7, remains brighter,” said Barret Kupelian, chief economist at PwC UK.